Note that this piece was written on 13-September 2023. For better reading, consider reading the PDF version here.
Executive summary / What really matters
MBUU is a leading designer, manufacturer, and marketer of a diverse range of recreational powerboats. It is a small cap stock with FY23 revenue at US$1.38b.
Investment Thesis 1 - Calmer waves than you think: The Street has overblown the severity of short-term industry headwinds and underappreciated MBUU’s mid to long-term growth runway
- The Street maintains an increasingly bearish outlook towards the recreational boat industry, stemming from a hawkish Fed, which I believe are overblown.
- In the short-term, the Street has overlooked replacement demand from Hurricane Ian that will soften pain from normalizing pandemic-induced demand.
- In the mid to long-term, the Street has also underappreciated MBUU’s potential to capture growth underpinned by changing consumer patterns and its ripe potential for internationalization.
Investment Thesis 2 - A sturdier hull than it looks: The Street has misunderstood the resiliency of MBUU’s demand profile and undervalued its enviable financial position
- Sales is more resilient to economic cyclicality than at face value due to access to premium buyers.
- MBUU has a surprisingly low operating leverage, indicating a relatively small fixed cost base.
- Prudent capital structure, profitable and OCF positive business model places MBUU in a favorable position to scale and offers it a large buffer for failure against downturns.
Investment Catalysts - Several clear levers for potential stock re-rating/price uplift:
- Outperformance of Street consensus in upcoming earnings can quell short-term pessimism
- Sell-side conferences MBUU is increasingly participating in can be used to clarify misunderstandings
- An increasingly likelihood and confidence of the US avoiding a recession can revive investor confidence
- Underperforming against Street consensus due to stronger than expected subduing of demand
- Persisting inflation coupled with a need for more marketing spend may erode margins
- Potential industry disruption with electric boats gaining more popularity
- Minimal primary research was conducted to validate thesis 1 & 2
Indicative Valuation of US$94-105 via the income approach:
Business Overview - Small cap recreational boat company with signs of trading at a discount
Overview: Founded in 1982 and IPO-ed in 2014, MBUU is a leading designer, manufacturer, and marketer of a diverse range of recreational powerboats. It has 8 brands under its portfolio with the premium Cobalt brands being the most profitable. 95% of its FY23 revenue comes from North America. Size wise, FY23 revenue at US$1.38b and market cap is just shy of US$1b.
Monetization and value chain: MBUU manufactures and then sell those boats to consumers (typically, older, richer, white male). The value chain largely consists of 4 steps. (i) Product development; design and engineering of the boats, (ii) Sourcing of inputs required; largely engines from General Motors and Yamaha, (iii) Manufacturing and assembly and (iv) selling the manufactured boats via a global network of dealers.
Strategic direction: M&A has become a core part of MBUU’s growth strategy lately, having completed 3 major acquisitions (Cobalt in 2017, Pursuit in 2018 and Maverick Boat Group in 2020) costing >$380m.
What caught my initial attention?: MBUU is a small cap stock with only 1 real business model (i.e. making and selling boats). This makes it easier to model and also analyze. Furthermore, it has been trading at a discount for some time and have recently seen its stock price being further punished due to increasing pessimism on economic outlook. I thought that it was worthwhile to dig deeper.
Competitive Landscape - Evidence of moat within an oligopolistic market
A lay of the land - Market structure best characterized as an Oligopoly
MBUU’s closest competitors are MasterCraft (MCFT) and Marine Products Corp (MPX), which like MBUU, are also pure-play recreational powerboat manufacturers in the United States. Zooming out, other competitors may include Brunswick (also sells propulsion, parts and accessories), Winnebago (also sells other recreation vehicles like vans) and Bénéteau (French, also sells leisure homes).
Evident wide economic moat when comparing against its closest competitors (MCFT/MPX)
MBUU has the most extensive distribution network amongst the 3, with 400+ dealers, including c.50% of dealers having >10 years of experience with MBUU’s brands. MCFT and MPX falls short with just 130+ and 190+ dealers respectively. This is a significant competitive edge given that dealer relationships take years to nurture. An extensive dealer network helps to push the product out more aggressively and covers more niche markets, giving an MBUU an edge over its competitors. Looking at the chart above, we can see that MBUU has consistently outperformed MCFT (it’s closest competitor) in revenue growth.
In terms of product value proposition, MBUU differentiates itself by focusing on enhancing its already impressive vertical integration capabilities. Note that both MCFT and MPX currently do not focus on vertical integration as part of their strategy. This will enable MBUU full control over key boat components, allowing MBUU to produce better products with heightened quality control and be more flexible with managing inventories and catering to fluctuating customer demands. Potential for margins expansion will also allow MBUU to price products more competitively vs peers and thus increase overall product value proposition.
Porter’s Five Forces Analysis indicates that MBUU is in a favorable position, primed for growth
- Buyer Power: Manufacturers like MBUU typically rely on dealers to sell to end consumers. There are no short of dealers available, and each are subjected to strict performance KPIs.
- Supplier Power: Increasingly lower given MBUU’s vertical integration efforts. But still largely rely on General Motors for engines.
- Degree of rivalry: Highly competitive space with 2 direct competitors. Nevertheless, MBUU shines via its distribution network and product value proposition.
- Threat of new entrant: Immense technical know-how, brand equity, IP and capital investments needed creates strong barriers to entry.
- Threat of substitute: No close substitutes yet. While there is a possibility of electric boats gaining traction in the near-term especially with more ESG conscious consumers, they are still far away from being a significant threat.
Thesis #1 - Calmer waves than you think: The Street has overblown the severity of short-term industry headwinds and underappreciated MBUU’s mid to long-term growth runway
The Street maintains an increasingly bearish outlook towards the recreational boat industry…
As observed above, MBUU and the broader recreational boat industry is seeing a sell-off over the past 2 months, largely in response to prevailing pessimistic sentiments surrounding the global economy (since recreational boats are seen as discretionary items).
- Firstly, at the root of it, the US Fed continued to hike interest rates in late July, extending the current tightening cycle that began in March-22. The 5pp hike over 16 months is now the fastest in 4 decades and precedent hiking cycles have consistently resulted in US recessions. Higher interest rates coupled with a looming recession adversely impact discretionary items like MBUU.
- Secondly, JP Morgan has just downgraded a key competitor, Brunswick Corp on 11-Sep. The basis of which was an increasingly cautious dealer sentiment into 2H23 based off JP Morgan’s dealer fieldwork and management access.
- Thirdly, a recent earnings call (3-Aug-23) by OneWater Marine, MBUU’s biggest dealer (>100 locations), revealed that the company is “increasingly cautious as demand signals are pointing towards a retail slowdown”. Margins are also impacted because of a price war amongst dealers.
- Lastly, below consensus revenue and earnings guidance from MBUU’s key competitor, MasterCraft (MCFT) just 3 weeks ago also contributed to an industry-wide ripple effect.
…Which I believe are overblown. In the short-term, the Street has overlooked replacement demand from Hurricane Ian that will soften pain from normalizing pandemic-induced demand.
Hurricane Ian was a deadly Category 5 Atlantic hurricane formed in Sep-22. It is the most lethal hurricane to hit Florida since the Labor Day hurricane of 1935. The estimated total damages are north of US$75b, including 15k boats destroyed. MBUU’s CEO, Jack Springer briefly mentioned during the Q3 earnings call that “We have not yet begun to see the replacement of boats related to Hurricane Ian. Many of our dealers believe this will be very significant”.
An estimation of the incremental revenue impact from replacement demand arising from Hurricane Ian can be computed as seen in the sensitivity table above. In my base case, I estimate a $73m uplift across FY24-25. This is done via a top-down approach by multiplying key assumptions: (i) 15k boats destroyed (source: MBUU Q3 earninigs call), (ii) 40% replacement rate across FY24 and FY25 (source: sentiments gathered through the various sources informal and formal sources like forums, social media, etc.), (iii) MBUU captures 8.7% share (source: latest FY23 market share).
In the mid to long-term, the Street has also underappreciated MBUU’s potential to capture growth underpinned by changing consumer patterns and its ripe potential for internationalization.
While weaker consumer sentiments may indeed cause a short-term drag in demand for MBUU’s boats, I believe that demand will remain robust in the mid to long-term, underpinned by structural shifts in consumer patterns that is MBUU well-positioned to tap on.
- Firstly, according to McKinsey, a younger consumer base is on the rise (pie chart above) – with Gen Z and Millennial consumers already being nearly twice as likely as Gen X or boomer consumers to express interest to purchase a boat. Millennials have already surpassed boomers in 2019 to become the most populous consumer group for boats in the US and Gen Z is expected to overtake them in 2036. The addition of new demographic groups enlarges the addressable market. MBUU is especially well-positioned to capitalize on this emerging trend given that its Axis brand was formed specifically to target a younger demographic.
- Secondly, there is a rising consumer-value for outdoor activities catalysed by covid-19 that is here to stay (bar charts above).
- Thirdly, the rise of subscription-based boat sharing clubs may enhance accessibility to such high-end boats and thus cushion fall in demand if the service take off in the mid-term.
- Lastly, the US$900b of unspent savings by US consumers during downturns provide a source of dry powder, boosting mid-term demand once sentiments are revived.
I believe that MBUU is uniquely positioned to capitalize on international expansion, and this is an upside that is yet to be noticed and priced in by the Street. Currently, there is significant headroom for internationalization. MBUU is overly concentrated in North America, with the region contributing to 95% of FY23 revenue. Yet, MBUU has a portfolio of well-established brands which are already market leaders in the US – such as in the performance sports boats space with Malibu/Axis and sterndrive boat category with Cobalt. Its market leader status in the world’s biggest recreational boat market will be sure to give MBUU significant brand recognition when expanding abroad. Furthermore, unlike its peers, MBUU already has 2 manufacturing facilities in Australia, which is in close enough proximity to service both the Oceanic and Asian market, regions which are seeing the fastest growth in no. of high-net-worth individuals (prime clienteles for MBUU’s products). Tapping on the international market can be a real needle mover as it can drastically increases MBUU’s total addressable market and may thus result in a re-rating of the stock.
Thesis #2 - A sturdier hull than it looks: The Street has misunderstood the resiliency of MBUU’s demand profile and undervalued its enviable financial position
Sales is more resilient to economic cyclicality than at face value due to access to premium buyers.
The same OneWater Marine (MBUU’s largest dealer) earnings call in August that highlighted pessimistic industry outlook also noted that “Premium inventory is still selling very well”. Similar sentiments are heard across other dealers. CEO Jack Springer also mentioned in Q2 earnings call in February that “premium buyers looking to purchase and has not really been affected by economic conditions or interest rates”. They are also unlikely to buy a used boat given that social class drives purchasing decision. Hence, MBUU's access to such premium buyers will provide it with vital insulation against macroeconomic cyclicality.
Given that MBUU has a significantly larger exposure to premium buyers vis-à-vis its closest competitors (chart above), especially after acquisitions of Pursuit and Colbat, the Street is neglecting the resiliency of MBUU’s portfolio and unfairly punishing its stock price alongside the industry.
The truth is MBUU’s portfolio resiliency was demonstrated at the onset of covid-19. Compared to its closest competitors, MCF and MPX, MBUU saw the least volatility on its top line. As seen in the chart above, revenue impact on MCF and MPX was almost twice compared to MBUU across CY19-CY20, the height of covid-19.
MBUU has a surprisingly low operating leverage, indicating a relatively small fixed cost base.
To further support my argument on MBUU’s portfolio resiliency, I calculated the operating leverage across key competitors. As illustrated in the chart above, MBUU has a surprisingly low 5-year average operating leverage of just 1.70x and 0.86x excluding an anomaly year in FY23. In fact, MBUU has the lowest operating leverage vis-à-vis its closest 2 other competitors. This is a positive for MBUU because it means MBUU has a narrower fixed cost base. MBUU’s profit margins will thus be least affected during a downturn when production and sales decline since there is a smaller fixed cost base to spread boats sold over. Again, this point reiterates the resiliency of MBUU’s portfolio, which the Street is failing to recognize.
Prudent capital structure, profitable and OCF positive business model places MBUU in a favorable position to scale and offers it a large buffer for failure against downturns.
Firstly, MBUU has an extremely prudent capital structure with no debt (excluding just $10m of other long-term liabilities) on its balance sheet. This means that (i) there is significant headroom to load up on debt to finance future growth plans (e.g., internationalization) and (ii) MBUU can easily tap onto the debt markets to raise capital in a downturn when it needs capital to stay afloat.
Secondly, MBUU has a tested and proven business model that generated positive operating cash flow since FY11 (earliest data available) and a positive net profit for all these 13 FYs except just FY11 and FY14.
Thirdly, MBUU has proven to possess robust and consistent cash flow generating abilities – even during downturns, as depicted in the chart above. Operating cash flow margins is at an average of 13.5% over the last 5 FYs. Note that future cash flow can largely be reinvested back to scale the business (alongside its existing $79m cash war chest; internal financing offers the cheapest cost of capital) since MBUU has no debt to service and still does not pay dividends.
Overall, these 3 factors indicates that MBUU has very enviable financial health that truly puts it in a favorable spot to aggressively execute growth plans while having a large enough buffer to comfortably weather through any short-term downturns. This characteristic is largely still undervalued by the Street.
Investment Catalysts - Several clear levers for potential stock re-rating/price uplift
Catalyst #1: Outperformance of Street consensus in upcoming earnings can quell short-term pessimism.
FY24Q1 and Q2 earnings call are expected to happen in Nov-23 and Feb-24 respectively. Outperformance of Street consensus will quell down short-term pessimism surrounding the macroeconomic downturn as the data will clearly demonstrate to the market that (i) replacement demand from Hurricane Ian can partly cushion some near-term pain and (ii) MBUU’s portfolio is more resilient than they get credit for. The Street will thus readjust consensus upwards causing valuations to rise closer to my indicative valuation.
Catalyst #2: Sell-side conferences like the upcoming D.A. Davidson Diversified Industrials & Services Conference can be leveraged to clarify inherent misunderstandings of the industry and MBUU.
MBUU is increasingly being invited to and participating at various sell-side conferences. On 6th June this year, MBUU took part in Baird’s 2023 global consumer tech and services conference. MBUU’s stock price rallied 12.7% from 5th to 7th June after the event. After all, these conferences offer valuable opportunities for management to address any misconceptions by the Street. The upcoming D.A. Davidson Conference scheduled on 21-Sep and other potential conferences in the future will give management a platform to highlight factors that are misunderstood, underappreciated, and overlooked by the Street – namely (i) MBUU’s portfolio resiliency, (ii) strength in financial position that gives it buffer to fail, (iii) ripe potential for internationalization, (iv) industry growth tailwinds backed by structural consumer trends.
Catalyst #3: An increasingly likely US soft landing materializing may dispel short-term consumer pessimism.
Despite the lengthy and still ongoing tightening cycle by the US Fed, the economy remains strong – supported by high levels of income growth. The looming recession indicated by the inverted yield curve does not seem to be coming. The VIX has gradually came down and US banks are now changing their outlook. For example, throughout 1H2023, BofA economist Michael Gapen had been calling for a recession. But he is now in favour of a soft landing after the latest batch of economic data sang a different tune. If this trend continues, alongside the Fed cutting rates in the near-term, the current pessimism surrounding recreational boats may quickly dissipate. Investors may then instead focus on long-term growth tailwinds bolstering the industry, specifically evolving consumer trends discussed in Thesis #1.
Overall, risks are low, supported by a simple liquidation value analysis (above), suggesting that even in liquidation, MBUU’s prudent balance sheet mean a max downside of just c.75%-83%.
Risk #1: Underperforming against Street consensus due to stronger than expected subduing of demand.
This can happen because (i) overestimation of replacement demand from Hurricane Ian, (ii) underestimation of the severity of the looming recession and its impact especially on the premium buyers.
Mitigation: This is a low likelihood risk because conservative assumptions are already used, and a bear case scenario has already been created in the model to reflect this risk. Even in the bear case, FY24E EPS is expected to be $7.64 and target price is $105.07, an 84.8% upside potential. After all, significant pessimism pertaining dampening demand has already been priced in giving us a compelling entry price. Also, past recessions in 1990 and 2001 have demonstrated that demand will typically pick up at least within the medium term – thus, holding on the stock for a slightly longer horizon can reduce risk.
Risk #2: Persisting inflation coupled with a need for more marketing spend may erode margins.
Persisting inflation and need for higher marketing spend due to the current economic downturn may erode margins and therefore impact valuations.
Mitigation: MBUU’s series of vertical integration initiatives allow for a lean cost structure. For example, MBUU decided to marinize engines for Malibu and Axis branded boats in 2019, reducing reliance on 3rd party supplies. Over time, these efforts will help MBUU better control rising costs from inflationary pressures.
Risk #3: Potential industry disruption with electric boats gaining more popularity.
With sustainability being the hot topic in recent years, electric boats have started to gain significant traction, just like with electric vehicles. MBUU lacks exposure to this fast-growing segment. Hence, any near-term movements or hype pertaining electric boats may shift consumers away from traditional internal combustion engine boats sold by MBUU. Furthermore, this poses a greater threat in the long-term as more customers get comfortable and adopt electric boats.
Mitigation: Electric boats are still far from mass adoption. Moreover, MBUU can always leverage its cash war chest and underleveraged balance sheet to quickly acquire electric boat capabilities.
Valuation Overview – Choice of methodologies
I arrived at a indicative valuation of US$94-105 via the income approach (equal bend of DCF using Gordon growth and exit multiple method) as the primary valuation methodology. The income approach was deemed more appropriate given its flexibility to capture the unique investment theses highlighted above. Market approach via (i) comparable companies analysis (P/E, EV/EBITDA) and (ii) analyzing MBUU’s historically traded multiples were used as sanity check against the target output. I did not rely on precedent transactions due to difficulties in finding suitable comparables and inclusion of control premium in such transactions, inflating valuations. The football field chart above summarizes output from each methodology.
Intrinsic Valuation – Discounted Cash Flow Analysis using Free Cash Flow to Firm
1) 3FS Modelling:
To begin, I projected MBUU’s 3 financial statements for the next 5 FYs. Given MBUU’s maturity, 5 years should be more than sufficient to converge to stable, long-term growth rate.
Firstly, revenue was forecasted separately for each of MBUU’s 3 business segments using a bottom-up approach by multiplying (i) average selling price (ASP) with (ii) volumes sold. A top-down approach by multiplying (i) recreational boat market size with (ii) MBUU’s market share was used as sanity check. Thereafter, incremental demand from Hurricane Ian, elaborated in thesis #1 above was added.
- In the base case, ASP was benchmarked to US inflation rates with the Saltwater Fishing and Cobalt fishing segments being better able to pass down cost to consumers given the premium customer profile highlighted in thesis #2 above – such profiles are less price elastic and more willing to pay for additional tech and features. Volumes sold was forecasted to see a slight dip before converging to industry growth forecast, underpinned by capturing structural consumer patterns and headroom for internationalization as mentioned in thesis #1. Again, the Saltwater Fishing and Cobalt segments will see more resilience to short-term demand softening due to access to higher end customers as explained in thesis #2.
- In the bear case, ASP is assumed to grow slower as customers are less receptive than expected to absorbing higher cost from inflation. Worse than expected macro downturn may also force MBUU to reduce price for certain brands to maintain demand. Waning US economic resilience and overestimation of resiliency of MBUU’s portfolio is baked into projected volumes sold in the bear case.
Secondly, margins are forecasted very conservatively both in the base and bear case by benchmarking historical averages. This ignores any margin expansion stemming from the massive vertical integration efforts that MBUU is currently investing in.
Thirdly, capital expenditure, depreciation and amortization are forecasted by taking historical averages alongside relying on management guidance.
Lastly, working capital is projected based on historical DSO/DIO/DPO with efficiency assumed not to improve.
Overall, my investment theses and views are baked into the financial model's assumptions, with the key output depicted in the Co vs Consensus table above.
Given that MBUU has a deleveraged balance sheet and the target capital structure is 100% equity, cost of equity = WACC in this case.
Cost of equity is computed using CAPM Model. Risk free rate of 4.25% was derived using US 10 Year Treasury Yield on valuation date. Professor Damodaran’s Equity Risk Premium was used as a proxy to derive a 5% market risk premium. For Beta, I chose to be more conservative and used 5 year monthly regression beta (1.61) over a bottom-up beta (1.21). Given that MBUU is a small cap, Size Premium of 3.21% is accounted for and calculated based on size premia in Kroll’s CRSP Deciles Size Study, using the Absolute Method by decile category.
Cost of debt though not necessary was calculated by deriving an implied synthetic credit rating using guidelines from Moody’s. A default spread based on an A2 rating was added to risk-free rate to derive a 5.33% cost of debt.
3) Terminal Growth Rate and Exit Multiple:
TGR was benchmarked using US target inflation rate of 2% and validated with other long-term growth forecast by the likes of IMF, FitchConnect. The US 30-year treasury, often used as a proxy for TGR stands at 4.3%. A conservative exit multiple of 6.23x EV/FY+1 EBITDA was derived from the 25th percentile of my comps set – way lower than MBUU’s 5-year historical multiple of 8x.
4) Scenario Analysis:
The table above summarizes the bull/base/bear scenarios, their assigned probabilities and target prices. As elaborated in risk #1, varying my assumptions for (i) ASP, (ii) volumes sold, (iii) margins expansion via vertical integration, I reach a $138.14 target price in the bull case and $88.98 target (risk) price in the bear (risk) case – still an 84.8% upside. How each of the 3 factors specifically impact target price from bull to bear case is seen in Fig 3.5. Nevertheless, I believe that the bear case is unlikely to materialize (20% probability) given that very conservative assumptions are already used in the base case and there is ample evidence to substantiate my variance views in thesis #1 and #2.
Relative Valuation – Comparable Companies Analysis
Using S&P Capital IQ, I screened for the following characteristics (i) public companies, (ii) leisure products, (iii) business description with “boats”. After which, a manual filtering process combing through each of the companies’ 10-K was done, keeping in mind similarity in monetization model and market cap, geographical segments. This yielded 6 comparable companies in total as seen in the comps table above.
Selection of Multiples:
Both EV/EBITDA and P/E were used because they use earnings denominators instead of revenue or operational metric given that it is a profitable business. P/B was not used because it is typically more appropriate for companies with more liquid assets (which are often fairly valued) vs fixed assets as in MBUU’s case. Forward multiples were used as valuations are inherently forward looking.
Board of Directors:
- Firstly, given the separation of the CEO and Chairman role, there is a clear division of responsibilities between leadership of the Board and Management – no individual has unfettered powers of decision-making.
- Secondly, 8 out of 10 Directors on the Board are independent non-executive directors, meaning that they are able to exercise independent business judgement and act in the best interest of the company.
- Thirdly, while slightly over-indexed in investment banking, the board members offer a wide range of expertise across various industries as seen in the table above. This helps to foster constructive debate and avoid groupthink.
- Nevertheless, we note that gender and race diversity can be improved. Most directors have been serving since 2014, which is a long tenure and may therefore have impacted their independence.
Executive Management: Top management has been together for >10 years – CEO Jack Springer joined in May-09, COO Ritchie Anderson joined in Jul-11 while CHrO Deborah Kent joined in Jan-11. However, the other executives appears to be relatively new.
Shareholders: MBUU’s free float account for 97.62% of outstanding shares, meaning MBUU enjoys a diversified base of shareholders. This reduces possibility of price-attacks from sudden sell-offs. There is also material inside ownership, positively aligning the interests of shareholders with agents of the business. 5.07% of MBUU’s shares are currently sold short, lower than MCFT (9.38%) but higher than MPX (0.87%). This highlights upside potential as short-sellers will have to close their positions one day.
Limitations of my Due Diligence
More extensive primary research can to be conducted
Given access to the right network and more time, I hope to further validate my theses by interviewing industry experts, dealers and customers.
- Firstly, I would like to speak with dealers and customers (and potentially running surveys) to better understand demand dynamics – especially price elasticity for each category of boats. Hopefully, this can further cement my thesis on resiliency of MBUU’s portfolio.
- Secondly, I would also like to interview management to delve deeper into their internationalization plans (e.g., what are management’s goals, pipeline, and ongoing initiatives to achieve those goals) as not much has been disclosed in the SEC filings. This will help to fortify my thesis on the market underappreciating MBUU’s long-term growth runway.
- Thirdly, I would also like to speak with employees to understand morale and work culture within the company to better evaluate the competence of current management as this is something that requires more on the ground insights to uncover the hidden truths.
- Lastly, I have never been on a recreational boat before. Thus, having access to the products would help me gain a deeper appreciation of the products sold.
Appendices - Financial Model
Discounted Cash Flow Model
Pro-Forma Financial Statements
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